Cube

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Retail Investors

Structured products are “complex instruments” this means that they will only be appropriate for you if you have sufficient knowledge and experience. In order to access the site you need to be able to agree to all of the following statements

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Risk Warnings

You should always bear in mind that;

  • You already hold other retail investments like funds, investment trusts or structured products
  • You would consider yourself to be a knowledgeable and informed investor
  • You understand the way that the investment return, the maturity value and any income are calculated by reference to the performance of underlying assets
  • You realize that you are not investing in the underlying assets but instead into a products whose performance is linked to these assets
  • You are prepared to invest into products where your capital is at risk
  • You have sufficient financial resources to be able to accept a loss on investments you make
  • You understand that the investment return and any coupon that you receive from structured products will depend on the performance of the underlying assets, and so you may not receive any investment return or income
  • The return of the capital may also be linked to the performance of the underlying assets. You understand how this is calculated, and appreciate that the amount that you receive back when a product matures may be less than you paid for it
  • The defined value of each product will only be realised if the product is held to the maturity date. You understand that if you sell a product before the maturity date you will not get the defined value, and the amount that you receive may be less than the amount that you invested.
  • You understand that if the issuer is unable to meet their obligations to pay the amount due when the product matures, that you will not receive the defined value and will loose some or all of the money you have invested
  • You understand that there are charges built into structured products.
  • You understand the personal tax implications associated with investing in structured products

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Persons accessing this website in the European Economic Area.

Exclusion of Liability

Certain documents made available on the website have been prepared and issued by persons other than CET Capital Limited. This includes any Prospectus. CET Capital Limited is not responsible in any way for the content of any such document. Except in those cases, the information on the website has been given in good faith and every effort has been made to ensure its accuracy. Nevertheless, CET Capital Limited shall not be responsible for loss occasioned as a result of reliance placed on any part of the website and it makes any warranty as to the accuracy of any information or content on the website. The description of any Security referred to in this website is a general one. The terms and conditions applicable to investors will be set out in the Prospectus, available on request and should be read prior to making any investment.

Risk Warnings

Investments of the type described therein may involve a high degree of risk, and the value of such instruments may be highly volatile. Such risks may include, without limitation, risk of adverse or unanticipated market developments, risk of counterparty or issuer default and risk of liquidity. Accordingly you must independently determine, with your own advisors, the appropriateness for you of the securities/transaction before investing or transacting. You should always bear in mind that;

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Please read and agree to the following statements

Structured products are “complex instruments” this means that they will only be appropriate for you if you have sufficient knowledge and experience. In order to access the site you need to be able to agree to all of the following statements

  • I already hold other retail investments like funds, investment trusts or structured products
  • I consider myself to be a knowledgeable and informed investor
  • I understand the way that the investment return, the maturity value and any income are calculated by reference to the performance of underlying assets
  • I realize that I am not investing in the underlying assets but instead into a products whose performance is linked to these assets
  • I am prepared to invest into products where my capital is at risk
  • I have sufficient financial resources to be able to accept a loss on investments I make
  • I understand that the investment return and any coupon that I receive from structured products will depend on the performance of the underlying assets, and so I may not receive any investment return or income
  • The return of the capital may also be linked to the performance of the underlying assets.
  • I understand how this is calculated, and appreciate that the amount that you receive back when a product matures may be less than I paid for it
  • The defined value of each product will only be realised if the product is held to the maturity date. I understand that if I sell a product before the maturity date I will not get the defined value, and the amount that I receive may be less than the amount that I invested.
  • I understand that if the issuer is unable to meet their obligations to pay the amount due when the product matures, that I will not receive the defined value and will lose some or all of the money I have invested
  • I understand that there are charges built into structured products.
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News & Press Releases

New European regulations mask benefits of structured productsMay 16, 2016 - 12:42

As far back as 2012 the Financial Conduct Authority (FCA) required that structured products were tested to see that they were suitable and appropriate. What this meant in practice was to check that the risk profile of the product was in line with the attitude to risk of advised clients. Managers of discretionary portfolios were meant to be able to show that the product complemented the risk profile that they were offering. In reality this requirement was largely ignored and life carried on as before. The FCA then reiterated their requirements in the Thematic Review in 2015. This second paper caused issuers and manufacturers of retail products to take more notice, and sadly for many the response to this inflation of regulatory risk has been to curtail or reduce their use of structured products.

The FCA has never been prescriptive about what stress testing meant, but only required that the process should be subject to appropriate checks. The European Union have inevitably gone a stage further and in their new Regulatory Technical Standard, or RTS, they require that every retail product or packaged retail investment and insurance-based investment product (PRIIP) has a KID, or Key Information Document. This KID will include information about the expected risk and return of the product. The RTS is very prescriptive and describes in detail how the input to the stress testing process has to be calculated, and how the results of this process have to be used to calculate risk and return.

What are PRIIPS and who does this regulation apply to?

The link below is from the FCA site and offers some clarity about what a PRIIP is and who this regulation applies to.  

https://www.the-fca.org.uk/planning-for-priips-regulation-and-kid?field_fcasf_sector=unset&field_fcasf_page_category=unset

It is clear from this that structured products are PRIIPS if they are made available to retail investors and that these regulations apply to fund managers, discretionary fund managers and stockbrokers. Although it is not explicit and there may be some room for debate, in our opinion the rules apply to structured products bought by discretionary managers for retail clients.

When will this apply?

The New European Rules are now set, and will have to be applied from January 2017. 

Who has to generate the KID?

This is an interesting question, the responsibility to generate the KID falls on the product manufacturer, but it is not always clear who is the “manufacturer”.  In most cases for structured products in Europe ex UK this is the issuer. However, in the UK the position is more nuanced. The FCA has given specific responsibilities to the product manufacturer relating to the design, testing, targeting and distribution of structured products. It is possible that the issuers of products will assume this responsibility, but that implies a more invasive relationship with advisers and managers. 

The reality at the moment is that most issuers would like to duck the responsibility of being the “manufacturer” and claim that they are simply an issuer.  For issuers there is both a fiscal cost from having to generate KIDs and a regulatory cost as well.  If issuers pick up responsibility for the KID, do they also pick up the other responsibilities of being the product manufacturer? 

In our view investment managers and advisers that specify their own product terms and then getting quotes from one or more issuers are clearly assuming product manufacturing responsibility.  It is possible that issuer and investment manager are both responsible, we have already heard lawyers talk about co-manufacturing. 

We think that issuers and wealth managers will both look to each other to comply with this regulation and assume that the other will pick up the tab. Most issuers are simply not set up to do the stress testing as prescribed by the RTS. They do not have the processes and procedures in place to comply with the other requirements that the FCA imposes on the product manufacturer. Investment managers on the other hand are prevented from receiving any fee from the product by the RDR rules, and so may argue that they should not have to shoulder the burden and responsibility and costs that the new regulations impose on the “manufacturer”. 

The problem is exacerbated by the lack of any grandfathering of existing product. We understand that the JAC have written to the EU for clarification on this issue, and that the response has been that KIDS have to be generated on existing products. 

What is the PRIIPS stress testing process?

Broadly products are tested using a “bootstrap” process. This involves testing the product based on new hypothetical index series calculated. The new index returns are calculated using the distribution of daily returns from the last five years. 

The output from the stress test are then used to calculate the volatility of returns and the expected return. The volatility of returns is based on the loss that an investor may suffer, and the expected return is an IRR calculation.

The testing process is not just a one-off, at-issue test. There is a requirement to test products over time. The minimum frequency is once a year, but in reality the requirement to update a KID if the risk bucket changes, or if the expected return changes materially means that most products will have to be regularly re-tested. 

The good news here is that there is a clear and obvious overlap between the new European standards and the requirements that the FCA have imposed on product manufacturers. The analysis required to calculate the risk and return for the KID should be sufficient for the FCA as well.

Is the new KID analysis any good?

We think that there is much to applaud in what the EU now requires. They have defined a process that can be used to test a huge range of products which then allows an apples-with-apples comparison across a number of different axis. In particular they have described a way to calculate the risk and return of structured products that allows them to be compared with funds and other assets. 

Unfortunately, we think that some of the choices made by the regulator will minimise the benefits that structured products offer. 

  • The way that volatility is calculated in particular, means that defensive products with soft protection will appear to be much riskier using the new process.

  • Limiting the observation window used to collect data for the stress test will generate some strange results where short term performance becomes extrapolated to be a long term trend.
  • Finally, the risk buckets are very wide, and probably less granular than most attitude to risk scales. Risk bucket 3 includes products where the volatility is between 5% and 12%. 4 goes from 12% to 20% and 5 starts at 20% and extends to 30%. This could match to the old low / medium / high classification, but they seem a bit clunky in today’s environment if there is no decimal point. 

What are our early conclusions?

We are still waiting on some clarification from the regulator on a number of issues, and will reflect the new requirements in the analysis that we provide. In the mean time we have come to some initial conclusions. 

  • Product comparisons: the RTS illustrates how the risk and return from structured products can be compared to other investments. We anticipate that this will encourage the use of quantitative analysis to support the use of structured products in client portfolios because structured products can be shown to expand the efficient frontier. 
  • Risk ratings: an official risk rating mitigates the regulatory risk that causes many managers and advisers to avoid using structured products. Now that there is an official risk rating process for structured products we anticipate that more managers and advisers will consider using these assets.

  • Parallel analysis: the regulations describe a process for calculating risk and return, and also the specific parameters that should be used. We anticipate that the market will build on the foundations that these regulations provide, and develop processes and parameters that are expected to give better results.  

  • Product manufacturing:  we anticipate that there will be demand from discretionary managers for companies that can assume responsibility for product manufacturing that sit between issuers and investment managers. Companies like Cube can take on the FCA manufacturing requirements, and offer KIDs on the products we manufacture. 

  • Overlapping responsibility: the EU demand that the manufacturer creates the KID, the FCA requires that the manufacturer creates products that meet investor demand, both impose an on-going responsibility to monitor products. We would expect managers to demand more quantitative research and analysis. 

  • New product shapes: it seems inevitable that manufacturers will look to develop products that maximise return and minimise risk using the new process. For low risk investors we expect that low European barriers will give way to products that offer partial capital protection.


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David Stuff
  • Author

    David Stuff

David has been involved in equity derivatives, equity structuring and the structured product market for over 25 years. Before setting up CUBE in 2013 David worked at J.P. Morgan, Barclays and RBS. David has worked with and for retail product providers, discretionary managers and institutional investors.